Punj Lloyd

The stock of Punj Lloyd has declined 20 per cent over the last four months. Weak market sentiment rather than any significant change in the company’s fundamentals appears to be behind the decline. The company’s financial results for the year ending March 2008 reinforce the company’s strong earnings prospects.

We reiterate a buy on the stock of Punj Lloyd. Investors who entered the stock at higher levels can also consider accumulating it on dips. At the current market price of Rs 273 the stock trades at 13 times its estimated consolidated earnings for FY-10.

A huge ramp-up in order book, entrenched position in key markets and presence in segments such as oil and gas, that hold huge business potential, underpin our recommendation.

The company’s recent financial performance also indicates that the company is no longer mired by the low-margin legacy orders of subsidiaries and is well-placed to move ahead.
Results update

For the year ended March 2008, Punj Lloyd recorded a 51 per cent growth in consolidated revenue to Rs 7,753 crore. Net profits, after adjusting for exceptional items, grew 68 per cent to Rs 331 crore. Operating profit margins improved to 8.2 per cent despite legacy orders (of subsidiaries) that carry low margins.

The net profit for the year was dented by Rs 67 crore as the company had to reverse profits booked on a project executed by its UK subsidiary in the third quarter. The auditors have pointed out that the company has not made provision for potential revenue loss of Rs 300 crore on the contract.

Punj Lloyd’s management has clarified that changes in design and scope of work have led to a cost increase. This has partly been accepted by the client and the balance of 15 million pounds (Rs 125 crore) is under negotiation. The company hopes to recover at least the costs on the contract and profits have not been factored into.

Even if the company is unsuccessful in its claim, we believe that it does pose a material risk to earnings or stock price as this project forms a miniscule portion of Punj Lloyd’s current order backlog.
Bigger order size

Punj Lloyd’s current order book of Rs 19,600 crore has grown five-fold over its size at the time of its IPO in December 2005. The company has also been striving to move to big ticket orders that would help achieve better economies and margins.

A recent project worth over Rs 2,000 crore bagged by the company suggests that it may be making headway in targeting orders valued at $1 billion or more.

The current order mix continues to be tilted in favour of projects related to the oil and gas sector, while civil and power infrastructure projects account for about 35 per cent.

Backed by its Singapore subsidiary, Sembawang, Punj Lloyd has now become more choosy in accepting infrastructure projects as this segment is less lucrative compared to the oil and gas sector. The infrastructure projects bagged by its Singapore subsidiary are large-sized orders. However, the infrastructure segment, at this point in time, appears more susceptible to margin pressures from rising commodity prices. However, the company has said that 90 per cent of its total orders have pass-through clauses on price and this may be a mitigating factor.
Well-integrated

Punj Lloyd has made rapid strides not only in moving into new regions, but also in entering related business domains by acquiring the necessary capabilities through buyouts. Acquisitions and strategic stakes in companies have helped the company scale up its execution capabilities for large-sized orders and enter into new domains, within a short span of time. The company’s acquisitions have been primarily driven by the need to attain pre-qualification in new/larger projects.

To cite a few examples, the company’s stake in Pipavav Shipyard is expected to strengthen Punj Lloyd’s offshore business. The facilities of Pipavav can be leveraged for fabrication of offshore platforms and rigs for Punj Lloyd.

Similarly, the strength of its subsidiary, Sembawang, in designing and constructing residential complexes and townships, has encouraged Punj to sign a joint venture for real-estate development in the National Capital Region. A recent strategic stake in the UK-based Technodyne International (to support its terminal and tankage business) and tie-up with a Singapore-based company for Defence equipment also indicate that the company has been fast-tracking business opportunities through the alliance/strategic stake route. The company has been able to pursue this strategy while keeping its debt obligations within acceptable limits.

Punj Lloyd has also made plans to diversify into opportune businesses on its own. It has, for instance, started a subsidiary for providing onshore drilling services to oil and gas exploration and production companies.

The company expects delivery of two drilling rigs this fiscal. The move appears well-timed to tap into the demand created by increased drilling activity, after the New Exploration Licensing Policy.

Overall, Punj Lloyd’s strategic moves over the past year suggest that is systematically diversifying into businesses and geographies, much as the engineering major, L&T, has done.

The difference is only that L&T has added to its business portfolio mainly through the organic growth route while Punj has chosen the inorganic route to diversification. The latter is certainly a more aggressive and risky route to scaling up in size.